Fight Internal Fraud With 8 Precautions

Posted on Thursday, April 20, 2017

When you read in the paper that a "trusted employee" has been charged with embezzlement, it can be shocking. But then, of course, it makes sense because the theft involved a trusted employee. An employee who isn't trusted doesn't have much of a chance to commit fraud.

The Fraud Triangle

Research by Dr. Donald Cressey (of the Association of Certified Fraud Examiners) led him to develop a concept called the "fraud triangle." Basically, most fraud has three elements:

A financial problem. The person committing fraud needs help with a pressing problem, which can't be solved by ordinary financial resources.

The employee has access to funds.

Rationalization. The thief has an excuse or reason for the fraud.

Steps to help identify a fraud triangle:

Pay attention to employees so you know when they have financial problems.
Encourage honesty so employees find it harder to rationalize theft. This also prompts other employees to report unusual behavior.
Be fair and consistent when disciplining employees and make sure they know the consequences of committing fraud.

How can you ensure that internal fraud doesn't happen in your business? Distrusting everyone certainly isn't the answer. You need to implement and monitor internal controls and procedures to make sure that employees don't have an opportunity to steal. Duties should be segregated so that no one employee is able to commit fraud and then cover his or her tracks without anyone else noticing.

Internal controls generally involve common sense and paying attention -- not elaborate systems. Although there are countless ways fraud can occur, here are eight precautions that can help prevent it:

1. Enforce vacations. Make sure employees take some annual leave. Have other employees cover them during the time off. Many sophisticated fraud schemes can be uncovered with this simple step.

2. Check references. This is often overlooked. When hiring new employees, check references in detail and run background checks. Run a credit report on applicants and employees when making promotions. Statistically, employees with pressing debts or bad credit histories are more likely to commit fraud.

3. Minimize access to cash, inventory, and building entry. Make sure as few people as possible have key and alarm codes -- ideally, just the owners and top executives. Change locks every year or two and change alarm codes often (Don't use birthdays or other easily guessed combinations).

4. Take inventory regularly. Supervise the process closely. Have spoiled goods set aside for your inspection. Someone other than the person who orders, ships or receives goods should do the counts.

5. Watch cashiers. Don't let them void transactions without approval and watch to ensure they ring everything into the register at the right price. Approve discounts or markdowns.

6. Verify cash totals. Clerks should count and total the cash in the register at the end of their shifts. Then, designate a trusted person to recount the cash and compare it to supporting, detailed records. Bank deposits should also be compared with supporting documents. Bank statements should be opened and reviewed by a person of trust who reports discrepancies and unusual items to upper management.

7. Use a dedicated payroll bank account. Deposit the exact amount every period so you can recognize amounts that are fraudulently changed. However, this requires paying close attention to details like overtime and withholding so that the account doesn't fall below minimum balances due to legitimate changes in payroll.

8. Safeguard check handling. Use a "for deposit only" stamp on incoming checks, which can prevent employees from cashing them personally. A designated individual should open mail and list all checks with the date, amount, and payer information. Spot check the dates when checks in a bank deposit actually came in - they should be listed as received after the last deposit. Other safeguards involving checks:

Consider accepting electronic payments or a implementing a bank lockbox system to prevent employees from cashing incoming checks.
Monitor receivables and payables. Investigate discrepancies.
Don't let the same person who handles cash or other receipts take care of disbursements. When feasible, rotate the duties of employees with these duties.
Reconcile accounts at least monthly and follow up on items that don't reconcile with supporting documentation. Compare checks with the company ledger. Make certain that payees on checks match payees shown on the ledger.
Confirm that payees and amounts on checks are consistent with your company's practices.

These are just some of the controls your business can implement to minimize the chances of internal theft. Consult with your accountant for more safety measures.

Posted in Fraud & Forensics Group

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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